From business dispute to political fight: Can investment treaties help?

Prof. Srividya Jandhyala, ESSEC Business SchoolAsia-Pacific, along with Prof. Lauge N. Skovgaard Poulsen from University College London and Dr. Geoffrey Gertz of Brookings Institution, takes a radical new approach to assess the impact of investment treaties on the de-politicisation of investment disputes

Once upon a time, in the Amazon rainforest…

The American firm “Occidental Petroleum” entered into a contract with the government of Ecuador to explore oil in the Amazon in 1999. Five years later, the Ecuadorian government claimed that “Oxy” had improperly sold a minority stake in the deal and thus threatened to expel them from the country. The dispute escalated rapidly onto the diplomatic agenda, with Oxy reaching out to the American embassy. Soon enough, the US Ambassador had raised the issue in separate discussions with Ecuador’s President, Trade Minister and other influential people in the government – the US Ambassador categorically pointing out that Ecuador would lose several trade benefits with the US if it cancelled the Oxy contract. But despite the coercions, the Ecuadorian government followed through with its threat and rendered the Oxy contract void, with the result that the US retaliated immediately by suspending the Preferential Trade Agreement negotiations with Ecuador.

This is a classic example of how a dispute between a private, foreign investor and a host country can become politicised, with consequences boiling over to the national level. Indeed, private investors often rely on diplomatic protection and lobby with their own governments to impose sanctions on the host government. And of course, this strains the diplomatic relationships between countries, resulting in direr repercussions than the ones that could arise from just a botched investment.

An alternate system of dispute resolution

Diplomatic consequences are bound to arise the moment private investors start leveraging state power to advance their own interests. One solution comes in the form of the international investment treaty regime. This regime allows private investors to directly hold host countries accountable for property rights violations through international arbitration. A private tribunal would have the jurisdiction to decide the dispute and award damages – in this way, occasional disputes around a private investment would not stop nations from enjoying the benefits of strategic alliances and cooperation.

For quite some time now, it has been asserted that such treaties are also in the best interest of developing countries who are on the receiving end of an investment. These countries often have limited economic, political, and military power to defend their interests. As such, international law is the best instrument available at their disposal to promote their agenda.

Stepping into the hidden realm of non-legalised dispute settlements

Experts believe that such legalised, third-party settlement of disputes can prevent individual disagreements from spilling over into other aspects of the bilateral diplomatic agenda between countries. In other words, access to investment treaty arbitration is expected to de-politicize an investment dispute between a private foreign investor and a host state. Professor Jandhyala and her colleagues decided to test this hypothesis. While past research typically relied on data from publicly-known arbitration claims, meaning that these studies ignored a larger category of disputes which never make it to arbitration, their work was different. They relied on new data gleaned from US State Department diplomatic cables. About 250,000 diplomatic cables consisting of internal communications within the US State Department were publicly leaked by WikiLeaks in 2010-11. This gave them access to information on 219 investment disputes involving American investors and foreign governments in 73 developing countries from 1996 to 2010.

Do the numbers add up in support of investment treaty regimes?

The diplomatic cables divulge a world of non-legalised dispute settlements. Sometimes, the US government took no actions on behalf of the investors. In other cases, responses of US officials ranged from the mundane to the dramatic; from writing letters of support or making phone calls to extensive diplomatic lobbying In cases of serious diplomatic intervention on behalf of investors, the actions taken by the US government included either (i) explicit threats to cut aid, trade or other US benefits, or (ii) implicit pressure by raising the issue with the heads-of-state or in official diplomatic visits.

The results of the study have been rather counter-intuitive. The share of disputes with serious US diplomatic engagement is almost the same in countries with and without US investment treaties: 30% vs 29%. It was also found that for an ‘‘average” dispute which is not covered by a US investment treaty, the predicted probability of serious diplomatic intervention is 12% vis-à-vis 15% for a similar dispute with an investment treaty. This difference is small and statistically insignificant. The regression analyses revealed that host country characteristics such as GDP and investment risk profile are also not a significant predictor of US intervention.

In a nutshell, the authors found no evidence that diplomatic intervention is less likely in disputes where American investors had access to investment treaty arbitration than in those disputes where investors lacked such access.

These findings were further reinforced when examining events through a more qualitative lens. Looking back at the Occidental Petroleum case mentioned earlier, it is interesting to note that the US and Ecuador actually did have an investment treaty in place. In fact, this treaty allowed Oxy to eventually sue the Ecuadorian government and receive $1.8 billion in compensation. But that did not stop Oxy from first working with senior American diplomats to assert political pressure and economic sanctions on the Ecuadorian government. Moreover, there seems to be no evidence that US diplomats were reluctant to intervene in this dispute because of the treaty.

On the other hand, despite the absence of an investment treaty, disputes between the Brazilian government and American energy companies such as Enron, El Paso and NRG Energy never veered to the political territory. In these disputes there was only minimal US diplomatic engagement.

Treaties are not the sure-fire recipe to avert conflicts

Developing countries are routinely encouraged to consent to investment treaty arbitration in return for less politicisation of their investment disputes. But it is time to question whether the benefits of de-politicisation may have been oversold to them. Just as the presence of an investment treaty did not result in a de-politicisation of investment disputes in Ecuador, the absence of an investment treaty did not result in a politicisation of investment disputes in Brazil.

It appears that investment arbitration is considered merely to be an additional tool for protecting investment, rather than an alternative to diplomatic intervention. While it is true that diplomatic interventions have grown less aggressive and coercive over the past decades, there is no denying that the explosion in investor claims still cost developing countries heavily. We may have reached a point where policymakers need to step back. And take a long hard look at the whole purpose behind investment treaty regimes.

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